Enovis - Q1 2024

Transcript

Operator (participant)

Good day, and welcome to the Enovis First Quarter 2024 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on a touch-tone phone. To withdraw your question, please press star then two. Please note this event is being recorded. And now, I would like to turn the conference over to Kyle Rose, Vice President of Investor Relations. Please go ahead.

Kyle Rose (VP of Investor Relations)

Thank you, Mary Elise. Good morning, everyone, and thank you for joining us today on our First Quarter 2024 Results Conference Call. I'm Kyle Rose, Vice President of Investor Relations. Joining me on the call today are Matt Trerotola, Chair and Chief Executive Officer, and Ben Berry, Chief Financial Officer. Our earnings release was issued earlier this morning and is available in the investor relations section of our website, enovis.com. We'll be using a slide presentation in today's call, which can also be found on our website. Both the audio and the slide presentation of this call will be archived on the website later today. During the call, we'll be making some forward-looking statements about our beliefs and estimates regarding future events and results.

These forward-looking statements are subject to risks and uncertainties, including those set forth in the safe harbor language in today's earnings release and in our filings with the SEC. Actual results might differ materially from any forward-looking statements that we make. The forward-looking statements speak only as of today, and we do not assume any obligation or intend to update them except as required by law. For further details regarding any non-GAAP financial measures referenced during the call today, the accompanying reconciliation information relating to those measures can be found in our earnings press release and in the appendix of today's slide presentation. With that, let me turn it over to Matt, who will begin on slide three. Matt?

Matt Trerotola (Chair and CEO)

Thanks, Kyle. Hello, everyone, and thanks for joining us this morning. We had a strong first quarter, but before I begin to discuss the results, I want to welcome the Lima organization to Enovis and recognize the efforts of our strong global teams who work hard every day to execute our strategies and help our patients live more active and fulfilling lives. Please note that as we fully integrate into one company with a global focus, we're managing the organization on a combined global basis, and we use pro forma growth for comparative purposes. For year-over-year comparisons, our prior year financials have been updated to include the acquisitions of Lima and Novastep. Let's start on slide three and talk about some of the quarter's highlights. We had a transformational start to the year.

We completed our planned acquisition of Lima, made significant progress on our integration plans, and carried forward momentum from 2023 across our geographies and business units. We delivered reported growth of 27% year-over-year and 5% on a pro forma combined basis versus very strong comps. We expanded our adjusted EBITDA margins by 220 basis points, reflecting the mixed impact of Recon growth, productivity improvements, stable inflation and pricing trends, and the step change impact from Lima. We closed the Lima acquisition in early January and are seeing strong momentum and healthy scaling of the broader set of acquisitions we've completed in the past few years. Overall, a strong start to the year. In Recon, on slide four, we delivered 66% reported global revenue growth.

Pro forma Recon grew 7% year-over-year in the first quarter, which includes a 2%-3% negative impact from integration dissynergies, in line with our plan. U.S. Recon grew 4%, including 8% growth in U.S. extremity and flat performance in hips and knees, against a very strong prior year comparable of 22% growth in our core Enovis business. Outside the U.S., we grew 10% in a resilient market. We have achieved significant progress integrating the Lima acquisition and are encouraged by the early execution of our combined teams. To date, we have seen some short-term growth impacts across anatomies and geographies as we've worked through the integration of our commercial channels. These fall well within our projected estimates, and our expectations for the full year remain intact.

We look forward to ramping cross-selling opportunities as we move into the second half of 2024. I'm excited about the initial traction we're seeing with our market-leading EMPOWR and AltiVate products globally. We continue to expand market access with the clearance of our AltiVate Small Shell in Q1 in Europe. We also have a strong pipeline of innovation as we continue the U.S. rollout of the EMPOWR Revision Knee, controlled ramp of ARVIS 2.0, and selling Lima's 3D printed Trabecular Titanium cones for use with our EMPOWR Revision System, one of our first key cross-selling opportunities. I'm also very excited to announce that just earlier this week, ARVIS received 510(k) clearance for use in shoulders. This timing aligns well with our planned launch of the augmented glenoid component of our flagship AltiVate Reverse Shoulder System in the second half of the year.

Our Foot and Ankle team continued to launch great new differentiated technologies, like the Arsenal Reload, that are keeping the vitality high and helping drive very strong double-digit growth. These great new technologies, alongside the cross-selling potential of the combined portfolios, offer significant opportunity to accelerate growth in the second half of 2024 and set us up with great momentum as a billion-dollar-plus, fast-growing recon business entering 2025. In P&R, on slide five, our 3% organic growth reflects a stable market environment and disciplined execution. Overall, this business is performing in line with our strategic plan. Recovery Sciences led growth, boosted by continued double-digit laser growth, and global bracing continued to grow above market rates. Our new product pipeline is robust and includes the new OA knee brace called ROAM, additional spine bracing products, and the next generation of clinical electrotherapy products for our Recovery Sciences team.

Adjusted EBITDA margins in P&R improved 50 basis points year-over-year, as we continue to use EGX tools to drive consistent productivity improvements and sustain traction on price versus cost. Now I'll let Ben take you through the P&L details. Ben?

Ben Berry (CFO)

Thanks, Matt. Hello, everyone. I'll begin on slide six. We are pleased to report first quarter sales of $516 million, up 27% versus the prior year, and 5% on a pro forma basis. This compares to strong prior year organic core growth of 9%. Our teams have been working really hard to integrate our global Lima acquisition that closed January 3rd. We've been extremely pleased so far with the collaboration in our teams and the high-quality integration plans that we've begun executing against. Our underlying growth in P&R and Recon continues to be solid, and while still early, our integration efforts are slightly ahead of our original plans. First quarter adjusted gross margin was 58.7%, up 70 basis points year-over-year.

The growth was driven by leverage from higher sales, favorable segment mix, which includes the addition of Lima, and cost leverage. Our first quarter adjusted EBITDA margin of 16.1% was up 220 basis points versus Q1 2023. First quarter's effective tax rate was 23%. This is compared to 21% last year. Interest expense was $20 million for the quarter versus $6 million in 2023. Overall, we posted strong adjusted earnings per share of $0.50, 14% earnings growth versus the prior year. Foreign currency exchange had an unfavorable impact of approximately $0.02 in the quarter. Turning to slide seven, we are raising our prior guidance to reflect the strong start to the year. We now expect revenues in the range of $2.06 billion-$2.16 billion.

This is slightly above our previous guidance range, which contemplated 7% pre-Lima organic growth, double-digit recon growth, and low single-digit P&R growth. As we go forward in 2024, we will be reporting on pro forma results. Our updated guidance range increase translates to approximately 5%-6% pro forma growth and includes acquisition-related impacts. In recon, the pro forma outlook translates to high single-digit growth for the year. We expect this growth to accelerate in the second half as we annualize higher prior year comps and begin realizing benefits from cross-selling and new product launches. We continue to expect stable P&R growth in the low to mid-single digits, as was reflected in our original guidance.

We expect adjusted EBITDA in the range of $368 million-$383 million, which includes a modest increase to the range based on our Q1 performance. Our guidance for depreciation, interest, and other expenses, tax rate, and share count remains unchanged from the prior guidance. Taking all this into consideration, and as a result of our strong operational results in the first quarter, we are increasing our adjusted earnings per share range to $2.52-$2.67. To summarize, on slide eight, we had a solid start to 2024 and continue to shape the business towards accelerated growth and scale with the acquisition of Lima. We are excited about our progress in the first quarter and remain focused on successfully executing against our integration plans, creating momentum, and delivering strong financial results.

Now I'll hand it back over to Kyle to start Q&A. Kyle?

Kyle Rose (VP of Investor Relations)

Thanks, Ben. Before we begin the Q&A session, in an effort to accommodate everyone on the call, we ask that analysts please keep the questions to one question, followed by one follow-up question. You're welcome to rejoin the queue if we have time. With that, we'll hand it over to the operator to start the Q&A.

Operator (participant)

Thank you very much. We will start the Q&A. You may press star, then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. Again, star one to enter the queue. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time, we'll start with a question from Vik Chopra from Wells Fargo. Vik, please go ahead.

Vik Chopra (Equity Research Analyst)

... Good morning, and, thanks so much for taking the question. I'll keep it to one. So, you know, based around on our math, Lima came in ahead of our estimates. We estimated about $85 million. Can you just talk about what you're seeing with regards to the integration and what drove the upside? And then you also called out 2%-3% negative growth impact from the integration. Would really appreciate if you, if you can elaborate on that, please. Thank you.

Matt Trerotola (Chair and CEO)

Vik, I missed the very end of the question there about the 2%-3%.

Vik Chopra (Equity Research Analyst)

Oh, sorry, I was saying we saw, you called out 2%-3% negative growth impact from the integration. Just any color on that would be appreciated. Thank you.

Matt Trerotola (Chair and CEO)

Yeah, yeah. Yeah, absolutely. So yeah, I mean, we saw, you know, a good solid start to the year as expected, you know, both in terms of our performance on the integration front, you know, as well as, you know, driving good progress in the core business. You know, that we've talked about through the quarter, you know, in various settings, you know, we talked about the market environment, which, you know, really last year there was a super clean market environment and very high utilization rates. You know, I think this year was probably a more normal market environment with storms and illnesses and different things.

So I think that, you know, that's resulted in, you know, a little softer market growth, a bit softer than last year. And so that's, you know, certainly an impact, but we've continued to, you know, drive strong performance, you know, against the market. But then we have been working quickly to do the integration as we've talked about, all along. And as we've worked through the channel integration, you know, in the U.S. and in certain countries outside the U.S., there are choices that we've made, in some cases, choices that agents have made in other cases, that have led to some, you know, some loss of business that was planned and expected.

And, you know, as we've talked about all along, we've tried to work through it quickly, so that we can have it, you know, kind of impact the business here in the first year and then, and then leave it behind. And that's impacted the U.S. significantly, but also it's had some, you know, impact in other countries. And it's had impact, you know, on the hip and knee side as well as on the shoulder side.

And so we've tried to give you a clear look with the pro forma growth, but also talk a little bit about the impact of the integration, so that you can see that, you know, the underlying business is certainly, you know, in a quarter with a strong comp and a little softer market, but the underlying business is still, you know, very strong, and we've got a great path to accelerate through the year and execute the, you know, exit the year on a very strong growth arc.

Kyle Rose (VP of Investor Relations)

Thank you. Next question?

Operator (participant)

Our next question comes from Jeff Johnson from Baird. Jeff, please proceed.

Jeff Johnson (Senior Research Analyst)

Yeah, thank you. Good morning, guys. So Matt, I don't wanna give you a big softball here, but I guess just help me on the math. If you did 7% recon growth, is it fair to think about those two to three points of dissynergies? I think you also had one less selling day with Easter at the end of the quarter. You know, recon, would that have been closer to, you know, 9%-10%, 10%-11%, if not for those dissynergies and the selling days? Is that how we should be conceptually thinking about this?

Matt Trerotola (Chair and CEO)

Yeah, yeah, I think that's, that's the right way to think about it, Jeff.

Jeff Johnson (Senior Research Analyst)

Okay. Then just on the extremity side, you know, you called out the 8% growth there. You did point most of that to foot and ankle. Obviously, you had the dissynergies, the selling days that impacted there as well. But just, can you talk about your core underlying kind of shoulder growth, whether that's just in the core Enovis, the AltiVate product in that? Obviously, competition is growing in shoulders as well. So just, you know, how do you perceive kind of shoulder market and your performance in the shoulder market ex kind of some of this noise from the integration and selling days? Thanks.

Matt Trerotola (Chair and CEO)

Yeah, excluding some of the integration impacts, we still, you know, see ourselves, you know, in a good, you know, above market growth range in our shoulder. And, you know, we have a great opportunity to work through the year here to, you know, even strengthen that further. The augmented glenoids that we will launch, you know, kind of here, probably late in the second quarter and really ramp in the second half of the year are gonna give us a great additional weapon in terms of driving more share gain in shoulders, and the cross-selling opportunities are terrific in shoulder. And then, as I said in my comments, we've also gotten, you know, ARVIS cleared in the shoulder.

And, you know, while that won't have much impact this year, in terms of revenue, because we'll be in the early launch phase, I think it just, you know, continues to send a very strong message to the market about our, the strength of our leadership in shoulder and our commitment to be continuing to be an innovation leader there.

Jeff Johnson (Senior Research Analyst)

Thank you.

Operator (participant)

Our next question comes from Young Li, from Jefferies. Young, please go ahead.

Young Li (SVP and Equity Research Analyst)

All right, great. Thanks so much for taking our questions. I guess, I wanted to hear a little bit more about cross-selling opportunities as you get through some of these early integration choppy periods. Seems like, you know, we'll see more of the benefit in the second half in the U.S., and, you know, U.S., oh U.S. seems pretty solid. Maybe you can talk a little bit about timing as well as key products within categories on cross-selling.

Matt Trerotola (Chair and CEO)

... Yeah, yeah, for sure, Young. Thanks, thanks for the question there. Yeah, I mean, we are, we're extremely excited about the cross-selling opportunity. Actually, I got to join the global sales conference that we had over in London for our Recon teams, and it was really tremendous to see how far the teams had already gotten on creating really specific and aggressive cross-selling opportunities. You know, I'll mention you know, a few. First, we talked about here in the U.S. market, you know, a kind of immediate opportunity to bring revision cones into the U.S. market and more aggressively sell the custom ProMade products that Lima has.

And so it's early days on those, but we've already, you know, gotten a little bit started there and, you know, would expect to see a nice ramp down the back half of the year on those. And we also, our teams are pretty excited about the SMR shoulder, not as a kind of our core shoulder product. The AltiVate is really our flagship. But there are, you know, specific situations where the SMR can be quite attractive, and we expect to see some nice cross-selling there, as well. You know, second, outside the U.S., you know, we're still early days in terms of driving the EMPOWR and AltiVate in. You know, we have just started to ramp up the Mathys cross-selling.

And so now across a much broader landscape with Mathys and Lima's channels, we've got a great opportunity for many years to come with EMPOWR and AltiVate. And as I shared, we just got some additional market access, which is very important in AltiVate. You know, a large portion of our cases in the U.S. with AltiVate are small shell, and so that market access really helps give a boost there on those broad cross-selling opportunities.

And then the third thing that actually is, you know, is really exciting. I kind of probably kind of underappreciated it until I was at this conference, sitting in the room with the teams talking about it, is there's a number of actually very interesting cross-selling opportunities between Lima and Mathys, revision products on the Lima side that the Mathys team is excited about, allergy-free products on the Mathys side that the Lima team are excited about. And so there's really this kind of organic energy that has come between those teams in terms of some, you know, some things outside the U.S. beyond the, you know, the sort of larger and longer AltiVate and EMPOWR opportunities.

So a lot of great opportunities, you know, getting them ramped up right now, doing a lot of training in this meeting in March, now starting to get the instrument sets into the market, get the funnels built, and we'd expect that, you know, down the back half of the year, we'll start to see the synergy ramp and start to hit kind of full struts, full stride going into next year.

Young Li (SVP and Equity Research Analyst)

Very great. That's very comprehensive. I'll just keep it to one. Thank you.

Kyle Rose (VP of Investor Relations)

Thank you. Operator, next question.

Operator (participant)

The question is coming from Brandon Vazquez from William Blair. Brandon, please go ahead.

Brandon Vazquez (Equity Research Analyst)

Hi, everyone. Good morning. Thanks for taking the question. I'll ask two upfront here. The first is just, as you guys are integrating Lima here, can you talk to us about logistically, what needs to happen still? What are the milestones we should keep an eye out for? Are there any ERP integrations, SAP integrations, things like that? And then maybe the quick follow-up as well is, just a little bit of, can you give us some color on gross margins, how they trended in the quarter, and how you expect those to trend through the rest of the year, especially as you integrate some of the, the Lima business as well? Thanks.

Matt Trerotola (Chair and CEO)

Yeah, thanks, Brandon. You know, as far as the key integration milestones, you know, some of the biggest focus so far has been on the commercial side, working through the different channel decisions and the implementation of them, and we're a good way through those in the U.S. and outside the U.S. Ramping up the cross-selling, as I talked about, has been another key piece of the integration so far. There have been some, you know, quick and thoughtful cost actions that we took in the first quarter in terms of starting to get after the cost opportunities.

There's more of that to come, but we did some, you know, some very quick moves as we put the two teams together outside the U.S. and as we tucked the US team into our team here in the U.S. So that's been another key thing that we've done so far. You know, as we look forward, yep, there are some things to do in terms of IT systems, but we're taking a very thoughtful step-by-step approach on that. So there's no big, scary ERP integration coming, that you know could be a big issue. More of a kind of step-by-step making the changes in terms of, you know, kind of SKUs and systems and how systems interchange and connect, et cetera.

We will, you know, work our way into kind of well-aligned systems, but that that's not, you know, any kind of, you know, big, big, giant thing versus a step-by-step, thoughtful approach. We've also got, you know, a couple years of operational synergies to get after over the coming years. That'll be, you know, step-by-step movement of things that are getting us cost opportunities, you know, some insourcing, some movement types of things. And then finally, we've done a lot of good work on just thinking about how the innovation pipelines and the product lines are going to come together, and making some early choices around that. You know, but it'll be, again, a thoughtful, you know, multi-year process of merging the innovation pipelines and product pipelines.

So we got a great managing process, great talent focused on this. So far, things are going very well. We know it's important to stay on top of that, though. There's, you know, there's certainly a lot more work to come. We feel very good about where we are right now. Yeah, and Brandon, on gross margins, we were, you know, 70 basis points ahead of last year... in the quarter. We would expect that to slightly accelerate through the course of the year, especially as we kind of get aligned with all the things that we've been talking about here. Both businesses, you know, continue to leverage the EGX capabilities that we have, and I would see some, you know, decent progression throughout the course of the year there on gross margin.

Kyle Rose (VP of Investor Relations)

Thank you. Operator, next question?

Operator (participant)

Next question comes from George Sellers, from Stephens. George, please go ahead.

George Sellers (VP and Equity Research Analyst)

Hey, thanks, for taking the question, and congrats on the quarter. Maybe to shift to the foot and ankle portfolio, you called out that as a nice bright spot. Could you just give some additional color on maybe some of the specific devices that are driving such strong performance? And maybe how we should think about the macro environment and the health of the consumer on that portfolio versus some of the other devices in your portfolio? And then lastly, you know, what are you seeing from a competitive perspective as well?

Matt Trerotola (Chair and CEO)

Yeah, yeah, sure. So, yeah, foot and ankle had a good, strong quarter. I think it was a healthy market environment in foot and ankle. Maybe kind of a little less of a, you know, strong comp there and a, you know, good healthy market environment to start the year, and that's continuing here as we start the second quarter. You know, our team, you know, we've got a number of key technologies that drive the growth there. You know, our DynaNail products or the DynaNail family, based on, you know, nickel alloy, cheap metal alloys, has been very strong, and we continue to bring additional, additional technologies into that family.

You know, we've the Novastep product that we acquired in last year, in the minimally invasive bunion space, you know, are driving nice growth, as well, and we're excited about that participation now into that large forefoot market. We've also the Arsenal Reload that I talked about is the next generation of our plating products, which, you know, are applied across the space. And we've, you know, we've got IP-protected technology around, you know, the fastening devices on our plating and, you know, some really great new plates that leverage that technology that we think are gonna bring a real boost as well.

And STAR, you know, has gotten to, you know, as we've talked about, STAR is stabilized and I think ready to grow here now as well with some of the changes that we've made there. So a number of great technologies across foot and ankle. But then very importantly, our channel continues to get more aligned. We've now got almost 70% of our channel fully aligned to our products, and that's something that we did a lot of work over the past few years to get there. And we know that that's gonna pay a lot of dividends. A strong aligned channel that has taken us deeper and broader into the market with these great technologies is gonna continue to fuel our growth going forward.

And the products that we've acquired and developed over the past few years have really played a key role in exciting all these agents and distributors to become a part of our team.

George Sellers (VP and Equity Research Analyst)

Okay, great. Thanks for taking the question.

Kyle Rose (VP of Investor Relations)

Thank you. Next question, operator.

Operator (participant)

The next question is coming from Jason Wittes, from Roth MKM. Jason, please go ahead.

Jason Wittes (Managing Director)

Great, thank you. So just a question about the impact of integration. I know it was 2%-3% this quarter. Does that run through the year, or how should we be thinking about what the negative impact is or positive impact is for this year, quarter by quarter?

Matt Trerotola (Chair and CEO)

Yeah, so, you know, I think in terms of how much it impacts the year, you know, we shared $20 million-$30 million as the expected impact when we did the acquisition, and, you know, that's, you know, 2%-3% of our Recon is more than 2%-3% of Lima, of course. But, you know, but I guess I would say, you know, as we've talked about, we've been trying to get at this quickly.

I think that we're likely to see that go from where it is now, you know, probably increase a little bit in the second quarter as we get really in maybe probably the apex of you know the impact from these integration things. And then I would expect that the back half it would kind of flatten and drop as we get you know to the other side of some of the things that even started to impact us, you know, late last year or right at the beginning of the year. And also as we have some nice contributions coming through on the cross-selling side as well.

Jason Wittes (Managing Director)

Okay, that's very helpful. And then just really quickly, in terms of the launches for the shoulder. In terms of the rollout, is that typically a six to nine-month process, or what kind of timing should we be thinking about for how quickly you can roll those out and then they have an impact on the numbers?

Matt Trerotola (Chair and CEO)

Yeah. So the augmented glenoids will get into the market very quickly. You know, there's obviously some early market participation that then leads to broader. But we would expect the augmented glenoids, you know, will be ramping aggressively in the back half of the year, and we've got a lot of, you know, we already, you know, kind of, you know, in the process of the stocking of product and instrument sets to be able to ramp very fast in augmented glenoids. And we really think that's going to be very important. You got that shoulder, but more and more surgeons are using augmented glenoids in their procedures. You know, we think that not only will that...

You know, offer us some same-store selling opportunities in our existing surgeons, but it's really gonna turn the heat up on our surgeon capture offense with augmented glenoids. So that'll be a this year impact and a very meaningful one. ARVIS, you know, much more of a kind of next year and beyond impact, you know, will be. You know, it's cleared, we get in the market, start doing cases, you know, and getting, you know, feedback. It's, you know, new technology, and we wanna make sure that, you know, we get it, you know, to exactly what's gonna make a big difference in shoulder.

So for sure, we'll be iterative in terms of, you know, launching the second half of the year on, you know, that that gets us some, you know, some good feedback, and then iterating from there in 2025 and bringing more broader functionality. But, you know, for sure, you know, our surgeons are gonna, you know, be able to, you know, see crystal clear the vision of, you know, taking our, our great, preoperative planning, using predictive analytics, to, you know, to create a great, a great plan that can be presented intraoperatively, with augmented reality guidance, and then capturing the data intraoperatively as the surgeons are being able to use that guidance to do those shoulder procedures.

You know, that's, you know, you know, we're convinced that that's really gonna be a very exciting next wave in enabling tech for shoulders at a time that the market is ready for it.

Jason Wittes (Managing Director)

Great. Thank you very much.

Kyle Rose (VP of Investor Relations)

Thank you. Next question, operator.

Operator (participant)

Our next question is coming from Vijay Kumar from Evercore ISI. Vijay, please go ahead.

Vijay Kumar (Senior Managing Director)

Hey, guys. Thanks for taking my question. Matt, apologies if you answered this, but what was the organic performance excluding Lima, right? Because I think the original Lima assumption was there would be some acquisition-related disruption, and Lima would be flat. It feels like Lima came in about, and the integration-related impact was on the base business. Can you just walk us through, you know, why that impact was felt on the base business, not on Lima, and what Lima's performance was in the quarter?

Ben Berry (CFO)

Yeah, Vijay, I'll take that one if you don't mind. You know, as we contemplated the guidance for Lima, we knew that the channel integration work was gonna be something that we couldn't really predict which business it was, you know, gonna come from as we were making portfolio decisions, as we were thinking about how do we really kind of get to the selective alignment of our territories and making sure that we've got good participation, you know, in that. So as we think about kind of how we've seen it start to play out, is you've seen some impacts on the legacy Mathys business and the legacy Enovis business. But all of that was contemplated in the guidance that we gave with regards to the amount of revenue coming in as a result of the acquisition.

So we think it's most fair to really show the pro forma view to kind of include the all up, all in view of what's happening. And then what we've provided is our best view of, you know, some of the discontinuations and some of the dissynergies that, that came within the business, which we've said 2%-3%. So if you kind of strip out the underlying performance of the core business and kind of look for a traditional organic kind of definition, our view is that our organic business would've been a little over 8%, in the quarter for Recon. And then you add a little bit of boost to that if, if you kind of take into consideration, selling days as well. So that's kind of how we're thinking about it.

Underlying performance of the core brands are still doing well, but as we think about the channel coming together, in particular in the U.S. and some of the countries that have more overlap, that's where it's a little bit hard to really distinguish the difference between reported product and Lima versus legacy business. So that's why we think it's most appropriate to give the pro forma view. But overall, we still see strong performance in our core technologies.

Vijay Kumar (Senior Managing Director)

Understood, Ben. And Matt, on this. Sorry, just sticking with the Recon, US hip and knee, getting some questions here on flattish. I know the comp is tough. Was there any integration impact here on the US Recon side? And Ben, can you just clarify, when you say the underlying Recon was about 8%, was that 8% excluding the integration impact within Recon?

Ben Berry (CFO)

Yes, yes, excluding the integration impact. So we look at like for like, you know, kind of underlying performance, our view would be, you know, a little over 8%, and that would take out those impacts.

Vijay Kumar (Senior Managing Director)

Understood. And Matt, sorry, on this,

Matt Trerotola (Chair and CEO)

Yeah, your hip and knee-

Vijay Kumar (Senior Managing Director)

Yeah.

Matt Trerotola (Chair and CEO)

Yeah, just to pick up your hip and knee question, there are some integration impacts there. Look, you know, our hip and knee growth last year was 22%. And so there's an extremely strong comp there. And, you know, if you look over a longer time period, you know, these, the results for this year would be for the legacy business, 550% above 2019. And, you know, by our math, the industry in hip and knee is maybe mid-single, maybe high single digits above 2019.

So, you know, I think that the comp certainly is an effect in terms of the picture on hip and knee, and with or without the integration, we would have expected Q1 to be a softer growth quarter in hip and knee, given the strength of the comp. You know, second, there is an effect here that Lima in the U.S., while it was primarily a shoulder business, it did have a small hip and knee business. And the primaries in the small hip and knee business in Lima were not a focus at all and were shrinking, you know, as we exited last year. And so there's a little bit of a tug from that Lima business as well in hip and knee.

And then, you know, for sure, the integration effects are in hip and knee and shoulder, and there's, you know, some specific accounts and surgeons that we've lost as part of the integration that are having an impact on hip and knee as well. Now, if we look forward, you know, through the year, Q2 is another tough comp there, but then from there forward, the comps get much more normal. We also, you know, we'll start to clear through some of these integration effects, and we expect to, you know, be able to keep ramping the revision even stronger now as we have the Lima cones.

We've also got some additional accessories that we had coming through our pipeline on the revision side to give us broader access in revision. We, you know, we've got ARVIS to ramp more aggressively as we move through the year, as well. And so, you know, we've got plenty of confidence that our hip and knee growth will, you know, move back to a more normal range as we move through the year.

Vijay Kumar (Senior Managing Director)

Fantastic. Thanks, guys.

Kyle Rose (VP of Investor Relations)

Thank you. Next question, operator.

Operator (participant)

Thank you. We have a question from Mike Matson from Needham. Mike, please go ahead.

Speaker 11

Hey, this is Joseph on for Mike. Maybe just follow up on the hip and knee. Do you think there's still kind of a backlog there for hip and knee procedures, you know, larger than normal backlog, I guess?

Matt Trerotola (Chair and CEO)

Yeah. So again, you know, I think whether you look at the U.S. or you look outside the U.S., the cumulative growth since 2019 is still, you know, significantly less than five years of growth. So that does certainly suggest that there are unserved patients there. You know, if you look at early last year, the first, you know, four or five months of last year, things went really hot in the U.S., you know, and some countries outside the U.S., and I think that was, you know, indicative of that backlog that lies there, and you know, sort of a high utilization environment that enabled, you know, higher rates.

So, you know, I think it seems reasonable that there is still backlog to be worked off in hip and knee that can create some tailwind, you know, maybe later this year and in the years to come. But clearly, you know, clearly in the first quarter, you know, looking at what we understand about our results and looking at the other results that have been posted, you know, this was a you know, kind of a slower growth quarter at hip and knee in the U.S. than where things were last year. And so clearly, that backlog is not being worked off right now.

I think, you know, we saw and understood that working through the quarter, that there were just various effects that were constraining, you know, kind of surgical supply, whether, like I said, whether it was storms or, or, you know, flu and different things. And so, and that, you know, that's what used to be, used to be pretty normal, that in any given year, there were parts of the year where there were some crimps that were being put on supply.

So, you know, better months, worse months, better quarters, worse quarters, and I think we might be back into a more normal environment, and there'll be periods where things can run white hot because that backlog is there and the, you know, surgical capacity is very available, and there'll be periods where the capacity is a bit constrained, and that backlog just sits there.

Speaker 11

Okay, great. Yeah, that makes sense. And then maybe just another quick one on ARVIS, if you do have, you know, anything, anything more to add, appreciate the color so far, but I guess any metrics in terms of adoption or placements would be really helpful. I understand it's still, you know, early ramp, but yeah, anything else would be great.

Matt Trerotola (Chair and CEO)

Yeah. Yeah, so as I've shared before on knee, we've got a few, you know, sort of a few dozen surgeons using it right now. By design, you know, we got it to a number of surgeons, and we're really focusing on, you know, kind of having them use it a lot, you know, and making sure that all of them get ramped up in terms of utilization rates and that we learn things that we need to in terms of how people are using it, to make sure that as we move to, you know, taking it broadly into the marketplace, that it's, you know, it's gonna be successful, both in terms of helping us to gain business and grow, but also that the surgeons will be using it at high rates.

You know, if you look at some of the technologies that are out there, some are being used at high rates, and some are not, and we wanna make sure that ARVIS is used at high rates. And so this controlled launch, I think, puts us in a place to be able to make sure that happens as we work through this year. Definitely expect it to have a good positive impact on our knee business as we work through this year and get beyond that first, you know, that first couple of dozen surgeons into a broader marketplace, and then, you know, kind of, you know, years to come of opportunity to have good, strong impact from ARVIS and knee.

And also, you know, we continue to work on additional technology add beyond ARVIS, in terms of making, you know, that hip and knee value proposition stronger and stronger in the enabling tech workflow area. On the shoulder front, you know, just getting started this year. We've been working on that, obviously, for a little bit here because we just, you know, cleared the regulatory with 510(k). But, you know, it'll be just a very initial launch here in the second half of the year, to get really good feedback on the software and the hardware and the instruments, and then, you know, make sure that we make whatever adjustments we need to moving into next year.

There's also kind of multiple waves of technologies that we can bring through ARVIS there into the shoulder and gonna get a good, strong start this year and then build on that in 2025 and beyond.

Speaker 11

... Okay, great. Thanks for taking our questions.

Operator (participant)

As a reminder, if you would like to pose a question and enter the queue, press star one. We have a follow-up question from Vijay Kumar from Evercore ISI. Vijay, you may proceed.

Vijay Kumar (Senior Managing Director)

Hey, guys. Thanks for the follow-up here. On,

Matt Trerotola (Chair and CEO)

A bonus. You get a bonus, Vijay.

Vijay Kumar (Senior Managing Director)

Yes, I do. I wanted to touch on margin performance in the quarter. The gross margins were in line with your expectations, Ben? Because my understanding is Lima had, you know, somewhere in the 70s gross margins. So sequentially, when I'm looking at this, the mix improved, right? The dollar contribution from Recon improved, but gross margins flattish, but operating margin came in well above. So just talk about the margin performance and how we should think about like for the back half. Does this give increased confidence in the back half margin ramp?

Ben Berry (CFO)

Yeah, Vijay, I think the number that you're thinking about with Lima is not a U.S. GAAP number, it's an IFRS number. So if you really translate Lima historical numbers into U.S. GAAP, there's some shift between gross margin and operating expenses. So the kind of underlying gross margin in the U.S. GAAP kind of translation is more in the higher sixties than it is kind of into the seventies. So that plus some of the mix of the business where we're getting some of the sales, I'd say, you know, kind of gross margins were kind of largely in line with what our expectations were. As I said earlier, I would expect to see some acceleration of the company's gross margins, kind of as we go through the course of the year.

And overall, I mean, still excited about the opportunities of, you know, kind of potential synergies down the road as we improve our, you know, kind of our Recon globalization and supply chain. There's lots of opportunity for us to continue to really embed EGX, to look at opportunities to expand our gross margins, to continue to shape the mix of the business in the right way that'll help us to accelerate there. So like we've said, we still see the Recon business. Right now, we're in kind of a high 60s gross margin. We see opportunity to kind of get that well into the 70s, call it, you know, mid- closer to the mid-70s over time.

But this year, it'd be just kind of, I'd say, relatively steady progress, looking at where we are in Q1 and maybe seeing a slight acceleration or, you know, as we go through the course of the year.

Vijay Kumar (Senior Managing Director)

Sorry. On the operating margin line item, were there any timing impact of OpEx or synergies, cost synergies coming in above plan? Because it just feels like OM execution was likely about.

Ben Berry (CFO)

Yeah. I mean, we're happy with the start. I mean, we were able, like, like we've said, we were able to, you know, really identify what the, you know, go forward org structure was gonna look like as we closed the deal. So we were able to capitalize on some synergies right away, you know, maybe slightly above kind of our initial expectations in the first quarter. But again, still well within kind of our expectation of what we've said for the year is where we're currently thinking. And like I said, there's the shifts between, you know, kind of OpEx versus gross margin, which is, you know, kind of again, aligned with what our expectations were.

Vijay Kumar (Senior Managing Director)

Understood. Matt, maybe one for you on... I saw the ARVIS 2.0 within the presentation. Where are we on in terms of adoption of ARVIS? Are we at an inflection point? And what does 2.0 do, which is different from 1.0?

Matt Trerotola (Chair and CEO)

Yeah. So 2.0, yeah, I mean, 2.0 in the knee was, you know, after putting it out in a controlled launch, getting a lot of feedback, we went and made a number of improvements to the software and the hardware, that, yeah, you know, we're making it, you know, kind of easier to use in many ways, but also, making it really very seamless, with our EMPOWR instrument sets, as well. And so, the 2.0, you know, was then, you know, kind of more of a full launch, of ARVIS.

But we definitely decided to do it in a step-by-step way, just to make sure that, you know, given that it's a brand-new-to-the-world technology, let's get 15, 20 docs using it and get some good feedback, help them to ramp up, and then use what we learn there to make sure that as we go to a broader set of doctors, one, we've got, you know, we've got a great value proposition and be able, in terms of being able to help them understand how it's gonna, you know, gonna be valuable, but also, we've got the ability to help them to ramp up fast and effectively with it.

And so that's what the 2.0 launch was, and we're right on track with that in terms of, as I said, a couple dozen surgeons using ARVIS, and some using it very heavily, you know, some less heavily. The ones who are using less heavily, we're learning, you know, why and how do we ramp them up in terms of how heavily they use it. And there's some good learnings there, both about how to ramp surgeons fast, but also about which surgeons to target more, as we do the broader launch. And then as, you know, we've now got, you know, plenty of inventory on hand, ready to do a broader rollout as we work through this year.

A lot of excitement in the field, around the ability to, you know, to bring ARVIS to a broader set of knee surgeons, hip and knee surgeons, but particularly for the knee at this point, as we work through this year. So we would expect that number to expand and be a, you know, good facilitator to our knee conversion efforts, but also start to generate a, you know, small, but growing and high profit recurring revenue stream, on the knee front. On the shoulder front, as I said, it's just a, you know, just an initial launch.

So, you know, think of, you know, shoulder in the second half of this year being, you know, kind of where our knee was, you know, a year or so ago in terms of getting that first launch into the marketplace in the second half of this year, and getting some good feedback that allows us to keep revving and improving the product. You know, we've been focused on making sure that by 2025 we are right there in the market with a very strong shoulder ARVIS offering to continue to, you know, to be a strong leader there in shoulder with technology as we always have been. And we're right on track to that with this announcement about the shoulder clearance for ARVIS that just recently happened.

Vijay Kumar (Senior Managing Director)

Understood. Thanks, guys.

Kyle Rose (VP of Investor Relations)

Thank you, operator. Next question?

Operator (participant)

Thank you. We conclude our question and answer session now. With that, I would like to turn the conference back over to Matthew Trerotola for any closing remarks. Please go ahead.

Matt Trerotola (Chair and CEO)

Yeah, thank you for joining us this morning. I want to end the call by thanking our team members for a strong start to the year. We have a lot of momentum and excitement across the organization and remain committed to delivering value for our internal and external shareholders, stakeholders. Thank you for listening in today, and we look forward to sharing our second quarter results with you in early August.

Operator (participant)

This concludes the conference. Thank you very much for attending today's presentation. You may now disconnect. Have a great, great day.